Money in, Money Out

As any forward-thinking manager will tell you, the trick to handling cash flow is in the timing. Here's how to think about making the most of the cash in your company -- both your own and other people's

The riddle of the Sphinx of Thebes has nothing on the riddle of the flow of cash. For ages accounting organizations have been struggling to pin down a functional definition of cash flow. Here's what the auditing crowd has come up with: cash flow = net income + depreciation + amortization + depletion + deferred taxes + an assortment of other noncash figures. The theory is that restoring to income a noncash item previously taken as an expense presents a truer financial picture than the simple income statement does.

Unfortunately for a business trying to keep pace with its creditors, vendors don't accept such income-statement dollars as payment for real goods. In which case, one street-hardened entrepreneur we know has a better theory: Anyone who relies on an accountant for cash-flow projections should be shot.

A bit harsh, no doubt. Yet much the same conclusion must have been reached by the principals of Chesapeake Biological Laboratories Inc. (CBL), a pharmaceutical company in Baltimore, after they raised $3 million in a 1988 initial public offering. The founders hired "some business types," as cofounder and current chairman William Tew alludes to them, to spend the cash wisely. Within 18 months the business types had spent the company into insolvency.

Any grammar-schooler can predict that if you can't buy lemons, you can't sell lemonade. As far as cash flow goes, putting out more money than you take in doesn't do the trick, no matter how dazzling the bookkeeping behind it. CBL's owners, who have medical backgrounds, admittedly were blinded to the drain on real cash by "the language of accounting, which," Tew sheepishly explains, "was something that, as scientists, we didn't find meaningful."

What the good doctors did find meaningful was that CBL got thrown off NASDAQ for failing to maintain minimum net worth -- "minimum" meaning just about nil. They took out personal lines of credit to keep their company afloat, dismissed their crack financial team, and struck out on their own.

Basically, the expression cash flow denotes only that cash leaves a company's beginning cash balance, does something for a while to attract customers, and returns as the company's ending cash balance, either augmented or diminished. But have Generally Accepted Accounting Principles or the Financial Accounting Standards Board outlined pathways for that cash to take?

"When we went to our external accountants for advice on how to manage cash in a forward-looking way," Tew complains, "they insisted on describing what our financial situation was. But we needed something that anticipated how our cash account would stand at a given point in the future, a tool that could give us predictions."

Enter functional cash-flow analysis. Since no one has convincingly defined what proper management of cash flow can do, not to mention what it is, for the moment we'll call our analysis of it the study of the influence of business decisions -- or lack of them -- on a company's cash account at given points in the future.

Cash-flow management actually is cash management -- except the cash being managed may not yet have arrived. Cash-flow management can be as rudimentary as preserving future cash by not spending so much in October if December -- when October's bills will come due -- is traditionally a poor sales month and won't generate enough receipts to cover those bills.

The goal of good cash-flow management ought to be obvious: to have enough cash on hand when you need it. It's a simple concept, yet in practice it eludes even the biggest of operations. Industry almost lost Chrysler and Lockheed for lack of cash, and did lose Penn Central and Pan Am. The problem is, cash-flow analysis doesn't yield to intuition because it involves tomorrow. Profit is a friendlier concept, in that it's calculable right now and you don't have to have a business to produce it. In 1992 a company could have drained its cash account directly into securities yielding 8%, and -- without fussing over jobs, office space, equipment, or sales of a product -- received double the net profit margin of the average NASDAQ-listed corporation (which was 4% as of December 1992).

But that's no fun. Besides, it wouldn't work if everybody did it. Fortunately, entrepreneurs prefer the second-mortgaging, nickel-scrounging grind of running bona fide businesses. That's where the leveraging muscle of our kind of cash flow comes in, as invested capital meanders through raw materials, loan obligations, variable costs, machinery, taxes, and similarly quantifiable components of everyday commerce. By deftly playing one such element against another, you can harness other people's capital without their knowing it and dig up capital you never knew you had. You can think of cash-flow-engendered capital as a kind of magical purchasing power, since it's nothing you can log into your income statement, and if mishandled, it will disappear.

Given the twists and turns around which cash flows through the innards of a business -- each new direction determined by the last -- we can't detail specific cash-flow-management techniques in the limited space we have. Instead, we'll outline concepts that will get you started on thinking about those techniques. A device so marvelous that it can invest someone else's money in your company and convert someone else's working capital to your cash is well worth thinking about, don't you agree?

As an introductory mind stretcher, let's solve some third-grade arithmetic.

The Zen of Cash Flow: Quiz Number 1
As it passes over a bridge exactly one mile long, your car travels the first half at 30 miles per hour. How fast do you have to travel over the second half to average 60 miles per hour for the entire span? Try 90 miles per hour for the second half, add it to the first half's 30 miles per hour, and divide by two to get the average. Sure enough, it's 60 miles per hour.

But don't even bother pressing your foot to the pedal if that's your answer -- you've made the wrong assumption.

Someone with a cash-flow-oriented mind-set, who evaluates one phase at a time, recognizes the above problem as a question of the passage of time, rather than one of adding and averaging. To average 60 miles per hour over the mile-long bridge requires one minute. In traveling the first half-mile at 30 miles per hour, the car uses up that minute. However achievable- sounding it may be, your modest goal of averaging 60 miles an hour going over the bridge can never be achieved.